Two months ago, Stanley Fischer was very popular. He was praised to the skies by pundits, industrialists and MKs for displaying "leadership and courage," because he was not afraid to intervene in the foreign currency market and lower interest rates significantly. Only a handful criticized his conduct.

The critics said that the Bank of Israel must not intervene in the foreign currency market. There was no chance that such a move would be successful, they said, and therefore, it would only caused damage. They also said that Fischer should not lower interest rates, because that would lead to inflation. Today, they are regretfully saying: "We told you so."

The cynical part of this story is that the same people who applauded Fischer two months ago are not hesitating to attack him vociferously now. They say that he took a gamble, that he made a mistake, that he failed, and that he singlehandedly cause inflation to rise and the dollar to fall. How easy it is to be a kibitzer.

The truth is that Fischer himself was worried about the steps he took. He knew something was wrong when the president of the Manufacturers Association, Shraga Brosh, congratulated him for his intervention. And he was genuinely frightened when MK Shelly Yachimovich congratulated him for lowering interest rates. Fischer understood that if these two were backing him, he had a problem. He also realized that this showed the public had concluded that the governor of the Bank of Israel had abandoned the war on inflation and switched to a policy of propping up the dollar. That is the impression that was created, and that impression had a high cost.

The primary explanation for the public's economic behavior is expectations. If merchants and businessmen believe that the governor has relinquished his battle against inflation, they will expect inflation to go up. Therefore, they will rush to raise their prices, so as to avoid being suckers and losing money. But the minute everyone thinks this, all prices go up, far beyond what is necessary - and then these expectations become self-fulfilling, and inflation rears its ugly head.

That is what happened in April. Everyone raised prices. The Consumer Price Index shows that 75 percent of all products became more expensive last month. Even the neighborhood falafel stand raised its prices.

In such an atmosphere, the damage only spreads. The labor market is already showing signs of agitation. Labor unions have noted that wages are eroding, and one day they will stand up and ask for a raise. The politicians are also waking up. Only yesterday, Industry and Trade Minister Eli Yishai demanded at a meeting of the Knesset Finance Committee that child allowances be restored to their 2002 levels, while Social Affairs Minister Isaac Herzog said the stipends should be linked to the average wage. The Pensioners Party says there is a need to raise stipends for the elderly, and the Labor Party wants to enlarge the budget so it can give something to everyone.

All this creates excess demand by the government. And when this links up with the public's excess demand, together they will fuel an inflationary blaze.

Fischer dared to lower interest rates twice, each time by 0.5 percentage points, because he assumed that the Israeli economy was entering a slowdown, and therefore, inflationary pressures would ease. But it turns out that the slowdown is not as bad as many had anticipated - as the data on growth that will be released next Sunday will demonstrate.

The fact that most goods have become costlier, and not only food and fuel, suggests that this inflation is demand-driven. In such cases, monetary policy is critical: Had the governor not lowered interest rates, the money supply would not have grown and thus prices could not have risen the way they have. Some would have risen, but others would have gone down, thereby partially offsetting the increases. Inflation cannot exist for long without an increase in the money supply.

Some people scoff at stability. But it is worth remembering that the economy survived the Second Lebanon War, and is currently surviving rocket attacks on Sderot and Ashkelon, thanks to our economic stability. Investors are not fleeing the country, because they see a stable economy and low inflation. And this is an achievement that must be preserved.

There is another important reason to combat inflation: the social issue. Higher prices mainly hurt the weaker members of society; their wages erode and their mortgages become more expensive.

It also turns out that the central bank governor is not omnipotent. He cannot encourage growth and exports and also fight inflation. He only has one limited tool - interest rates - through which he can achieve one important goal: price stability.

In view of the fact that the current inflation is all a matter of expectations, Fischer must change direction and prove that he is embarking on an all-out war against inflation. This cannot be done with talk, only with actions: a sharp rise in interest rates. Therefore, Fischer must raise interest rates next week by 0.5 percentage points (not 0.25 percentage points), thereby altering expectations.

This will cause even the falafel seller to realize that someone up there takes his job seriously - and that will ensure that he does not raise the price of falafel again.

Haaretz.com, the online edition of Haaretz Newspaper in Israel, and analysis from Israel and the Middle East. Haaretz.com provides extensive and in-depth coverage of Israel, the Jewish World and the Middle East, including defense, diplomacy, the Arab-Israeli conflict, the peace process, Israeli politics, Jerusalem affairs, international relations, Iran, Iraq, Syria, Lebanon, the Palestinian Authority, the West Bank and the Gaza Strip, the Israeli business world and Jewish life in Israel and the Diaspora.